Statism new status quo

Bloomberg

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What’s good for General Motors may not ultimately be best for the global economy.

The Bush administration’s $13.4 billion rescue of GM and Chrysler is a fitting finish to a year in which governments around the world expanded their role in the economy and markets after three decades of retreat.

The intervention comes at what may prove to be a steep price. Future investment may be allocated less efficiently as risk-averse politicians make business decisions. Whenever banks decide to lend again, they are likely to find new capital requirements that will curb how freely they can do it. Interest rates may be pushed up by government borrowing to finance trillions of dollars of bailouts.

Not good in the long run
"We’re seeing a more statist world economy," says Ken Rogoff, former chief economist at the International Monetary Fund. "That’s not good for growth in the longer run."

It’s not good for stocks either, says Paola Sapienza, associate professor of finance at Northwestern University’s Kellogg School of Management. Slower economic growth means lower profits. Shares might also be hurt by investor uncertainty about the scope and timing of government intervention in the corporate sector.

"If the rules of the game are changing, people are reluctant to invest in the stock market," Sapienza says.

The bond market will also be affected as it is forced to absorb ever bigger increases in government debt. While yields on Treasury securities touched record lows last week, they eventually "will go up significantly and dramatically" under pressure from added supply, says E. Craig Coats, co-head of fixed income at Keefe, Bruyette & Woods in New York.

The increase in the government’s role in the economy has been breathtaking. The U.S. looks set to rack up a budget deficit of at least $1 trillion this fiscal year, while the Federal Reserve has already increased its balance sheet by $1.4 trillion since last December. By way of comparison, U.S. gross domestic product last year was $13.8 trillion.

Winding back the intervention may not be easy, says Sapienza, who has studied the effect of government ownership on bank lending.

When Italy nationalized banks in 1933, "the architects who designed the system envisaged it as temporary," she says. "It was in place until the end of the 1990s." More recently, the Japanese government injected capital into banks to get them to lend to big corporations, keeping alive "the zombie companies that economists talk about," she says.

Already, investors trying to decide where to put their money are "gambling very much on what they think the government will do, not what they think about the company," Sapienza says. "That’s why there’s so much volatility."

The auto-industry lifeline is just the latest in an extraordinary year of market interventions that have redefined capitalism. The U.S. government previously seized control of mortgage lenders Fannie Mae and Freddie Mac and insurer American International Group and took stakes in the nation’s largest banks.

Government activism has become a "necessary evil" to help pull the global economy out of recession, says Marco Annunziata, chief economist at UniCredit MIB in London.

Situation in Europe
Policy makers elsewhere extended their reach, too. The U.K. nationalized mortgage lenders Northern Rock and Bradford & Bingley. French President Nicolas Sarkozy created a 6 billion-euro ($8.7 billion) fund to invest in "strategic" firms. And the European Commission last week relaxed rules on state aid to businesses.

Back in 1953, when the U.S. auto industry was booming, GM Chief Executive Officer Charles Wilson famously observed: "For years I thought what was good for our country was good for General Motors and vice versa." If the automakers’ importance has declined, so - until recently - had the government’s.

Just a dozen years ago, U.S. President Bill Clinton declared that "the era of big government is over." Sarkozy won election last year promising a "rupture" from France’s history of heavy regulation; these days, the French president has changed his tune. "Laissez-faire, it is finished," he declared last month.

Bailouts and economic-stimulus plans are also running up government borrowing. Economists at JPMorgan Chase & Co. estimate the budget deficits of developed economies will more than double next year to 6.3 percent of gross domestic product.

Bigger deficits, while necessary now, could spell trouble down the road if they lead to higher borrowing costs or prompt consumers to save more now on the assumption that bigger shortfalls will mean higher taxes later. "We’ll end a financial crisis with a fiscal crisis," says Vito Tanzi, former director of fiscal affairs at the IMF. "We’ll get out with very large public debt and very large public spending. That, for sure, will slow down the rate of growth for the next 10 years or so."